Is The Chinese Stock Market Truly Uninvestable? (NYSEARCA:FXI)

cbarnesphotography From Jim Cramer to Goldman Sachs, a growing list of critics think China and Chinese stocks are “uninvestable.” Their distaste is understandable. China looks more and more like a can of worms, not for the faint of stomach. Still, early-bird investors may have a different palate. We consider both sides and evaluate if the Chinese stock market is truly uninvestable in 2024. Everything Wrong in China Seems like everything that could go wrong in China has gone so recently. A quick recap of the last few years. China went into freefall during the outbreak of COVID-19. It had a brief rebound as pandemic restrictions eased, but was short-lived. China persisted with “Zero-COVID” policies even as other countries eased restrictions. Quarantines, lockdowns, and coercive policies suffocated economic activity and sentiment. China unleashed an “anti-corruption” campaign from 2020-2022 that targeted successful tech companies like Tencent and Alibaba, spooking investors. Two pillars of the Chinese economy buckled and dragged on growth. First, manufacturing got a double whammy from domestic lockdowns and foreigners diversifying supply chains out of China. Second, economic weakness exposed the overleveraged and distressed nature of the Chinese real estate sector. Problems escalated into an ongoing nationwide crisis. Geo-political tensions continue to tighten. Trade wars, cold wars, IP disputes, human rights concerns, President Xi’s consolidation of power, and so on, the can of worms gets bigger. These issues and others led to massive capital outflows over the past three years. The stock market dropped by more than -60%, shown below as the iShares China Large-Cap ETF (NYSEARCA:FXI). This resulted in a loss of more than $6 trillion in market cap, according to Bloomberg. Data by YCharts Critics say the time for China was past. China’s role as the world’s factory helped it grow in the past. However, changes in costs, supply chains, and geopolitical dynamics have altered the future. Meanwhile, many see Chinese President Xi’s politics as a retrenchment into old CCP ways. That creates an unfriendly and inhospitable environment for business and foreigners. These concerns paired with seemingly never-ending lower lows in Chinese stocks have investors understandably questioning if China will ever recover, and if Chinese stocks are truly uninvestable. What is Not Wrong in China With so many problems, one might think it would be easier to ask what is not wrong in China. Easier said than done because silver linings are hard to see, but we can squint harder. A little help The Chinese government (CCP) understands state intervention better than most. That’s important here because financial markets often need a little encouragement and a lot of government help when times are tough. Even in the U.S., we have FDIC and public bailouts to backstop the financial markets. Likewise, the CCP has no plans to let its markets fail. Over the past year, Beijing has rolled out a series of policies to support its struggling stock market. According to the Chinese Securities Regulatory Commission, policies include reducing trading costs, restrictions on shorting and selling, state-backed funds to stabilize the stock market (buy shares), and incentivizing dividends, buybacks, and long-term investing. Meanwhile, China’s Ministry of Finance plans to invest $1.5 billion to improve China’s manufacturing competitiveness, and the People’s Bank of China announced a $42 billion program to support the real estate market. Some criticize these measures as too little and too late because sentiment and conditions have gotten so bad. However, markets often react to relative better or worse, instead of absolute good or bad. For example, while the U.S. and EU countries are tightening economic policies to restrict growth, China is one of the few countries loosening to stimulate. Relatively speaking, China’s stimulative policies look better for financial markets. It’s all relative Markets react in relative terms because they do not exist in vacuums. For example, bears focus on how China’s problems will drag on the economy and result in weak growth. That sounds bad by itself, but bad relative to what? In reality, China’s most recent GDP growth rate (Q1 2024) measured +5.3% y/y. Not only was that higher than the consensus expectation of 5%, but it is higher than every other major economy in the world, except India. GDP & Growth by Country IMF, Trading Economics, BCM Yes, 5% is lower than China’s past growth of 8%. However, China is also now the second-largest economy by a wide margin. 5%+ growth at China’s scale is impressive and unmatched in 2024. Looking forward But GDP is a coincident indicator and stock markets are forward-looking. The continued drawdown in Chinese equities suggests most investors believe conditions will get worse in China ahead. They could be right. Then again, the consensus is just as often wrong, if not more. Rather than speculate on price, we could consider fundamentals like leading indicators that correlate with changes in economic conditions. One example is S&P Global’s Purchasing Manager’s Index, or PMI, which measures business activity. Historically, the PMI tends to change ahead of the business cycle. PMI readings above 50 indicate expansion and readings below 50 indicate contraction. The Manufacturing PMI is of particular importance in China for obvious reasons. The index spent most of 2022 and 2023 below 50, but its latest read from March was the sixth consecutive print above 50, indicating an expansionary trend. S&P Global China Manufacturing PMI (S&P Global, Trading Economics) The OECD’s Composite Leading Indicator (CLI) is another forward-looking measure. It gauges broader economic activity (vs manufacturing only), and forecasts conditions 6 months ahead. After a challenging 2 years, the China CLI reversed into a strong rebound last year. OECD China CLI (OECD, Trading Economics) Of course, these indicators could be wrong. Regardless, the data show that Chinese economic activity has been (and is expected to be) better, while the consensus assumes it has been (and is expected to be) worse. Buy higher or lower Price may not matter, but valuation usually does (eventually). Like it or not, the only investing principle that really works is to buy low and sell high. Compared to the world’s 10 largest economies, China’s equity market is trading at one of the lowest valuations. This is despite, again, China having higher GDP growth than every other country, except India. China has the lowest price-to-book multiple, the second lowest price-to-earnings multiple, and the third lowest market cap-to-GDP multiple. This is summarized in the table below by country and respective ETFs. (Morningstar, IMF, BCM) It is also worth noting the Chinese stock market is trading near its lowest valuation levels of the past decade, and Chinese stocks are down about -30% over the past ten years. Assuming GDP growth of 5% and a forward MC/GDP multiple of 0.8x, I estimate the Chinese stock market could be currently undervalued by about 52%. Does that mean Chinese stocks have hit a bottom? No, I am not calling a bottom or trying to catch a falling knife. Also, the discount on Chinese stocks exists for a reason. Is it justified? I do not know. I am simply pointing out I prefer a valuation of 55% to GDP with 5.3% growth, over 193% to GDP with 2.9%. The same goes for 9.3x earnings versus 25.7x, and 0.9x book value versus 4.5x. Given a choice, and all else equal, I prefer to buy lower. The Risky Bottom Line There is no shortage of risks with China. Chinese stocks could continue falling for any number of reasons. The CCP could launch another crackdown, there could be a renewed trade war, and China could invade Taiwan, the can of worms just keeps getting bigger. Regardless of the issue, it seems many of the problems with investing in China lead back to the CCP. Investors simply do not believe the CCP can be trusted to honor the same freedoms investors are accustomed to in the West. How can people be expected to invest in China when the CCP can seize gains as state property on a whim, without cause or justification? I do not have a good answer. I can only agree this is one of many real and relevant risks of investing in China. So, does that make China truly uninvestable? No, it makes China risky, but not uninvestable. The truth is we have heard these critiques many times before. Calls to never invest in China have been around since before President Nixon first reestablished diplomacy with the CCP in 1972. But since then, early bird China investors (like the late, great Charlie Munger) got their fill on gains, while many of the never-invest flock are still tweeting about politics and their growling stomachs. Shanghai Composite Index Shanghai Composite, Log Scale (Macrotrends) Yes, China has its problems, but what country does not? Those problems do not negate that China is the world’s second-largest economy, still outgrowing most countries, and still has tremendous potential. I do not know if the Chinese stock market has hit a bottom, but I believe a long, patient position at current prices or better will be rewarded over time due to relatively attractive economic conditions, valuation, outlook, and a very pessimistic consensus. As for gaining exposure, picking single stocks offers the most upside, but, obviously, more risk as well. Those who do not want to pick stocks can gain broad Chinese equity market exposure through a fund like the iShares China Large-Cap ETF (FXI). The fund holds 50 large-cap Chinese stocks that trade in Hong Kong. It is one of the oldest, largest, and most liquid China ETFs, and currently trades at $25.89 per share. If you take a position, do it over time on price weakness. Whatever you do, do your homework, decide for yourself, and do not peck at more than you can stomach. Good luck hunting out there, we all need some.

Buy cryptocurrency

Source link

Refer And Earn Demat Account – Get ₹300 | Referral Program

Open Demat Account In Angel One For FREE